Credit Suisse’s autocallables linked to Brazil ETF show risk due to volatility, barrier type

By Emma Trincal

New York, Aug. 5 – Credit Suisse AG’s 7.5% autocallable yield notes due Aug. 14, 2015 linked to the iShares MSCI Brazil Capped exchange-traded fund are designed for yield-seeking investors, but the volatility of the underlying asset and the type of barrier used to provide the contingent protection reduce the appeal of the notes for a conservative investor, buysiders said.

Unlike other types of autocallable notes, these pay a fixed coupon, which will be payable monthly, according to an FWP filing with the Securities and Exchange Commission. The exact coupon will be set at pricing.

The notes will be called at par if the ETF closes at or above its initial share price on Feb. 11, 2015 or May 11, 2015.

The payout at maturity will be par unless the ETF closes below its knock-in level, 75% of its initial share price, during the life of the notes and finishes below its initial share price, in which case investors will be fully exposed to the ETF’s decline.

Donald McCoy, financial adviser at Planners Financial Services, said that investors ought to be aware that the higher yield is the direct result of taking on more risk with a volatile underlier.

“This is not an easy structure to understand. But basically, it’s for yield hunters who are comfortable using volatility to get the higher coupon,” he said.

Turnover

The autocallable feature reduces the overall risk of the product – a call will reduce the risk of losing principal to nothing – but may not offer the best outcome for investors, he said.

“The high yield and the protection are the two selling points, but there is a likelihood of getting called, and if you get called out, you’re not getting your full return,” he said.

“I suppose you go to the next one to realize your full coupon. That makes for a lot of activity in a client account. I guess this is more of a broker-dealer, commission-based type of product.

“On paper you get 7.5%, but you have to deduct the fees. If you jump from product to product, the client will end up paying a lot of fees as a result of this turnover. If you get called out, you’re not going to get the whole thing and you have to reinvest the money into something else.”

Not a CD

While investors in the notes may share the same appetite for yield as traditional bond buyers, their risk profile is likely to be different, he noted.

“It’s obviously designed for yield since you don’t participate in the upside,” he said.

“But unlike a typical fixed-income product, this carries with it the risk of substantial losses investors may not appreciate when they buy it.

“Income investors are used to more stability in their return. It would be tough for people to go from a five-year CD to something like this.”

The risk is in large part the result of the exposure to Brazil, he noted.

“The underlying fund is very volatile, just as most emerging markets. In Brazil, you have an emerging economy that is subject to strong market turns up and down. We’ve seen investors pouring into it and flying out of it quickly,” he said.

‘Troubling chart’

The shares of the ETF are up 9% this year to date and have gained 12% over the past 12 month, but the share price has experienced wild swings. From October 2013 to February 2014, for instance, the share price dropped by about 27%, which would have represented a trigger event.

“Brazilian stocks are not for the conservative investor,” Tom Balcom, founder of 1650 Wealth Management, said.

“This fund peaked in 2010 and has shown a downtrend since then even though it’s been doing better over the past few months. But if you look at the past four years, it’s a troubling chart.

“We’re dealing with a highly volatile reference asset. But if you’re an investor who is comfortable with Brazil and who wants some level of protection, this gives you a modest return.”

American option

Balcom said that the notes could find a place in a client’s portfolio but that extreme care should be given to suitability.

“I can see how people would buy it for income. And maybe somebody would want to use it as a high-yield replacement strategy,” he said.

“But this is the type of structure where it’s especially important to make sure the client understands everything.

“They’re not going to participate in the upside. They may lose money if the fund is down by more than 25% at any point in time. That’s the problem with American options. It can be triggered any day, and then you lose the downside protection. We prefer European options because it’s point to point.”

In options jargon, an American option can be exercised not only at the expiration of the contract but any time before that. In contrast, a European option can only be exercised at the expiration date.

“Finally, you have to explain to the client that Brazil is an emerging market and a particularly volatile one,” he added.

“It makes sense to use structured notes to gain access to this asset class because of the protection, but it depends on how much protection you get.

“We do have an allocation to emerging markets, and we use structured products because volatility is huge. We don’t go long-only with this asset class. We don’t buy mutual funds or ETFs in that space.

“This note is a volatility play on Brazil. You can get a decent return, but you really have to know what you’re getting in to.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price Aug. 11 and settle Aug. 14.

The Cusip number is 22547QRQ1.

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